It wasn’t so long ago that investment banks were queuing up to enter the ring and take the fight to the incumbents in the European cash equities marketplace.

Cash equities teams have been floored by high costs and low volumes

However, faced with a wearying fight in which the purse appears to be dwindling, many are now considering how they might box clever, or take out their gumshield and exit the ring altogether.

In a report on wholesale and investment banking last month, Morgan Stanley and Oliver Wyman noted that some businesses, while capital light and attractive on a Basel III basis, simply made no money at the bottom line in 2011.

One of those businesses was cash equities, and nowhere was this more evident than in Europe.

The report said: “There remains overcapacity in equities globally, with particular hotspots in Europe and parts of the business in Asia; this business has been overlooked for some of the deeper cuts given the attractive capital-light profile.”

The two firms expect the cash equities wallet to increase between zero and 5% from 2011 to 2012, compared with a 5% to 10% increase in equity derivatives, while JP Morgan analysts predict cash equities revenues will rise by only 1% from last year.

This comes after a sustained period of investment in the business by many, attracted by the promise of high returns in a capital-light business.

One global head of cash equities at a top-tier firm said: “Cash equities has always had a high cost-to-income ratio, and always will. In 2006, that ratio was all anyone cared about.

No one talked about return on risk-weighted assets, and so they weren’t interested in building in equities, when they could hire 20 more traders in fixed income.

“In 2009, I think people got carried away by thinking equities would be the business where they would make lots of money, just because it was attractive from a RoRWA [return on risk-weighted assets] perspective.

It got irrational. Unless you are running a pretty lean operation with sizeable market share, it is difficult to be profitable in this environment.”

Weak comeback

A rally in equity markets during the first quarter has raised hopes of a rebound in equities, but market participants point out that this rise, and a more recent reversal, took place on thin volumes, with fund managers still sitting on the sidelines.

Overall European cash equity market volumes were down by 17% in the first quarter, according to Thomson Reuters, compared with the first quarter of 2011.

So far, the second quarter has done little to support the argument of a broad-base recovery in global equities.

Citigroup in its results last week cited lower industry volumes in cash equities as a principal cause for a decline in equity markets revenues.

Laurent Quirin, chief executive of Kepler Capital Markets, said: “The early days of the second quarter are beginning to show an unwinding of the first quarter rally as worries over the sovereign debt yields of the peripheral countries have resurfaced.

As the health of the cash equity business is driven by absolute market levels, market volumes, margins and the health of our clients, it is not obvious that the outlook has significantly improved.”

This has left businesses with a European bias in a fix. To put it into perspective, take two global equities businesses of similar size and business mix.

One is skewed 60% to the US, the other only 30%. The difference in profits could be up to $100m, according to Morgan Stanley and Oliver Wyman, a substantial amount of money that might normally go towards funding cost-streamlining, growth plans and hiring.

The US investment bank and management consultancy said in their note that a further 5% in capacity has to come out of the equities business, with Europe hardest hit. Bigger houses, including UBS, Bank of America Merrill Lynch and JP Morgan, have been trimming staff in recent weeks.

Many in the industry think it will not be long before someone follows RBS and UniCredit in exiting the business completely. Brokers focused on mid-cap sectors in particular have suffered several body blows.

Siggi Thorkelsson, head of equities for Europe, Middle East and Africa at Barclays, said: “There is still excess capacity, and our expectation is that margins and secondary volumes won’t improve significantly soon.

“The other factor to take into account is the origination side, which has a sizeable impact on the economics of a cash equities business, and has been quiet for some time now.

We see a good pipeline in that business, but expect general market conditions to remain the same for the foreseeable future and are planning our business accordingly.”

One-two combo

The first move has been to cut jobs. Brokers are looking to reduce their footprint, focus on core sectors and clients. Those in the business say this tactic sounds good in the boardroom but is often difficult to execute.

Second, banks are increasingly looking at technology to increase their efficiency. In particular, this electronification of the equities market has moved to a second stage, where more and more banks look to outsource their execution or technology needs, rather than building costly services.

Deutsche Bank is exploring opportunities to outsource the operation of its internal European trading venue, Super X, while Societe Generale has launched a new venue, Alpha Y, using NYSE Technologies systems.

Richard Hill, global head of quantitative electronic services at Societe Generale, said: “There are significant volume issues at the moment and a reduced commission pool.

This requires brokers to be very efficient with their trading operations. Using third-party technology for the platform helps us to reduce fixed costs.”

Matteo Cassina, president at Citadel Execution Services Europe, said: “In my view, this year will be an important turning point, as outsourced execution becomes the next logical step in the evolution of the cash equities market.”